The money-exchange scheme announced in India by PM Modi on the evening
of November 8, 2016, has caused tremendous hardship to the people of the
country. More
than 50 people have died as a result of the policy, while countless people
have been forced into extreme hardship. Much more suffering is to come.

Three questions immediately present themselves. One, does the scheme
solve the stated objectives of eliminating black money and counterfeit money?
Two, does the country have the capacity to absorb the shock of removal of 86%
of the cash stocks in the country and their slow replacement, either by stocks
of new money or a cashless economy – a process likely to take months? Three,
and most importantly, does a better alternative exist?

There has been much debate on the first aspect – viz., whether the
scheme under implementation can solve the black money and counterfeit problem.
I will only discuss this briefly, and focus on the second and third questions.

I show in this article that the country simply does not have the
capacity to absorb the shock of the removal of 86% of the cash stocks in the
country.

Further, I also show that a much better alternative to the government’s
scheme exists – a scheme that does not focus on chasing stocks of black money,
but on completely eliminating black money and counterfeit money, once and for
all, in a painless process that does not involve people starving, losing their
livelihoods, or dying.

Large portions of this article recently
appeared in a column that I wrote in Frontline magazine – the entire
section titled “Flaws of the Demonetization Scheme” is taken verbatim from the
aforementioned Frontline article: this article expands on that column in order
to provide a comprehensive look at the problem, and a better solution than the
one the government has implemented.

Later interactions with the
government through press conferences revealed a third objective: A move of the
country to a cashless economy.

According to Modi's speech on the
evening of the 8th of November, all existing Rs. 500 and Rs. 1,000 notes would
cease to be legal tender by the end of the day; banks and ATMs would be shut
for the next 2 days to stock them with new Rs. 2,000 notes and notes of other
lower denominations; and after that, banks would start accepting cash deposits
and return up to Rs. 4,000 per person in exchange, the rest remaining in their
bank accounts; and ATMs would disburse up to Rs. 2,000 per card per day, up to
a total of Rs. 20,000 per week. (These limits have changed since and
are very dynamic, with new policies being announced virtually every day, which
points to a complete lack of planning.)

The impression given was that people
would be inconvenienced for just two days and then the bank branches, working
late hours and weekends, along with well-stocked ATMs, would relieve any stress
or anxiety on the part of the public.

I will not discuss any of these
issues here. My concern is more fundamental – whether the move to take out the
Rs. 500 and Rs. 1000 notes out of circulation and replacing them with new notes
was carefully considered in light of the existing infrastructure, and whether
alternatives exist.

Flaws of the Demonetization Scheme

The decision to remove the Rs. 500
and Rs. 1000 notes left most Indians in the lurch. This was because 86% of all
the currency printed by the government was in the form of Rs. 500 and Rs. 1000
notes (by value). According to the annual report of the Reserve Bank of India
(RBI) dated 29 August 2016, as of March 2016 the currency notes in circulation
had a total value of Rs. 16.42 trillion (or lakh crores). Of these, 86.4%, or
Rs. 14.18 trillion was in Rs. 500 and Rs. 1000 notes. This was the amount
sucked out of the system at midnight on November 8. It was estimated that, of
this amount, about 25%, or Rs. 3.5 trillion, was black, meaning that people
possessing it would not deposit it in the bank for fear of attracting huge
penalties or jail time. That would mean that the amount of money in circulation
that would now need to be deposited in banks and exchanged for new notes is
approximately Rs. 10.64 trillion. This is to be done entirely through bank
branches and ATMs.

In press interactions since the demonetization
move was taken, the FM has informed the people that this move is part of a
larger plan to move to a cashless economy, and urged people to start using
electronic banking, mobile payment, and credit and debit cards. The attempts by
people to exchange their now-worthless money for new, usable notes hit another
roadblock as ATMs needed to be recalibrated to accept the new notes, a process
the FM estimated as needing another three weeks. In yet another interaction, PM
Modi informed the nation that he expected the hardship to continue until
December 30th at the latest.

But is this realistic? Are the two major
legs on which the demonetization scheme stands, viz., for citizens to deposit
old notes in banks and withdraw their money using either bank account
withdrawals or ATM withdrawals, or the transition to a cashless economy for 50
days, relying only on ATMs, bank branches, smartphones, credit and debit cards,
realistic at this time? What percentage of Indians actually do have access to
these?

The Global Financial Inclusion
report, prepared by the World Bank,
gives a lot of useful information to answer these questions. The data shows
that while things are improving, they are nowhere near where they need to be.
For instance, the percentage of those 15 years or above who had a bank account
rose from 35% in 2011 to 53% in 2014. The number of ATMs per 100,000 Indians,
on average, was around 18. This compares unfavourably to other countries like
66 in South Africa, 129 in Brazil, and 184 in Russia. Clearly India is a lot
more unprepared to deal with a situation where 86% of the cash vanishes
overnight than any of these nations. Figure 1 shows the availability of ATMs in
several countries over the last decade.

Figure 1. Availability of ATMs in Different Countries

Credit and debit card usage does not
fare much better. The Global Financial Inclusion report says that in 2014, only
11% of Indians 15 or above made a payment using a debit card, and only 3.4%
used a credit card; and only 2.2% used a mobile phone to make payments.
Further, it says that in 2014, only 6.4% borrowed from a financial institution,
whereas 12.6% borrowed from a private lender; 6.6% borrowed from a store by
buying on credit; 5.4% borrowed from an employer; and 32.3% borrowed from
family or friends. The Indian economy is therefore dominated by cash and
unaccounted transactions, and most people are quite unfamiliar with electronic
means of payment and withdrawal. Only 20% received their wages at a bank. Less
than 0.2% of Indians used a mobile phone to pay utility bills; just over 4% of
all Indians used a bank account for business purposes; just under 4% of Indians
used a bank account to receive government transfers; and only 6.7% used checks
to make payments.

What is very clear from these figures is
that a large majority of Indians are not even in the formal banking/financial
net, let alone specialized forms of it such as internet banking and mobile
banking using smartphones. Further, it should be kept in mind that these
figures, dismal as they are, do not reflect the true desperation of the
situation today, because they are average figures for India and do not reflect
the urban/rural divide.

Figure 2, taken from the RBI’s
“Report of the Committee on Medium-Term Path on Financial Inclusion,” dated
28 December 2015, shows that the bank branch density in rural areas is less
than half of the bank branch density in urban areas. Rural India is largely
cash-driven. One reason for this is that agricultural income is exempt from
income tax, and a lot of transactions are done with cash alone. This is not
black money.

Figure 2. Variation in Bank Branch Density in Rural and Urban India

So, the irony of the situation is that bank
branches and ATMs are far fewer in the rural areas, but the percentage of
wealth that is held in cash in rural India is much greater than what is held as
cash in urban India, where people use banks to store their money – and now
these rural Indians will have to contend with getting their larger stores of money
in and out of banks with little experience doing so and this during a liquidity
crisis!

The Jan Dhan Yojana has created a lot of
new bank accounts in India, but a lot of them are zero-balance accounts, and
people have not yet taken to using them.

It should be clear from the above that rural
India was woefully unprepared for the shock of the withdrawal of 86% of liquid
currency on November 8, and is unlikely to recover from this situation any time
soon.

One of the main thrusts of the economic
policy of this government is the JAM troika – standing for Jan-Dhan Yojana,
Aadhar unique identification, and Mobile. The RBI’s Economic Survey of India
2015-2016 discusses, in Chapter 3, the JAM approach in detail and presents a
JAM preparedness index – i.e., how ready is India for a world in which benefits
will be transmitted electronically to bank accounts, verified by Aadhar cards,
and accessed by mobile phones – in other words, a cashless economy, of the kind
people have been forced to confront themselves today. A JAM preparedness index
of 100% indicates full preparation, and 0% indicates complete unpreparedness.

Figure 3 shows the JAM preparedness index for urban India, and Figure 4 shows
the index for rural India. It should be very clear that India, especially rural
India, is neither ready for a JAM world, nor was it ready for the world of
November 9, 2016.

Figure 3. JAM Preparedness Index for Urban India

Figure 4. JAM Preparedness Index for Rural India

This is going to lead to unbelievable
suffering in the next 50 days. People are going to starve and die – many
already have; people are going to continue to be refused medical treatment for
life-threatening illnesses and pregnancies for lack of liquid cash; and farmers
are going to suffer as they cannot sell their produce or buy seeds. Business is
going to come to a standstill in both rural and urban India. The worst effects
of this measure will be felt by those with the least
capacity to absorb these shocks.

An Alternative Solution

One of the arguments put forth by the
Government and its supporters is that there was no alternative to all this pain
and chaos – that this was the only way.

“Do you not want black money and counterfeit money to be ended?” they thunder.

Indeed, we do. Every right-thinking
person in this country would like a more honest system in which there is no
black money and no counterfeit money. But there are many ways to skin a cat.
The way the Government has chosen is full of fatal flaws.

Is there a better alternative? Yes,
there is – a painless alternative that will not result in anyone losing their
livelihoods, their health, or their lives. And I will discuss that here.

It is clear that all these problems
experienced by the people are because of the fact that the system simply does
not have the infrastructure for people to exchange their money and get new
notes in a reasonable time-frame. That is because the necessary tools, viz., online
banking, internet connections, smartphones, physical banks and ATMs, and credit
and debit cards, are simply not widespread enough. In other words, the problems have happened because the
government has put the cart before the horse.

Therefore, the better alternative
would have been for the government to first build the necessary infrastructure
– to invest in last-mile connectivity for banks; to invest in cheap smartphones
(as they did with the Akash
tablet) so that every Indian could afford one to engage in financial
business; to ensure national internet connectivity; to get every Indian in the
banking net; to make all Indians use only debit and credit cards for purchases;
and to make all Indians use mobile apps such as PayTM or apps using the new Unified Payments Interface (UPI) to make even the smallest
purchases, such as buying vegetables on the street.

This will take time and have to be
done in a calibrated manner, by both investing in the infrastructure as well as
working on people’s inertia, by gradually closing off alternative means of
payment such as cash in sector after sector.

So the government could announce, for
example, that all supermarkets and malls would no longer accept cash for
amounts greater than Rs. 500 after six months; that in the next one year, the
Railways will stop accepting cash for tickets and only accept electronic
payments such as credit cards, debit cards, internet banking, mobile wallets
such as PayTM or Mobikwik, and payment banks under the UPI; that in six months after that, no government office will
accept cash for any transaction; and so on.

This will force more people to go
cashless – but it will give them sufficient time to prepare for a cashless
economy – to open bank accounts, to get debit and credit cards, to obtain cheap
smartphones subsidized by the government, to learn how to use apps such as
PayTM or UPI-based apps, to use ATM kiosks for internet banking to pay bills,
and so on. Since it will not be an overnight change, it gives people time to
learn these new tools and make an orderly transition. There will be no panic
and no one will die of shock. If there is a wedding or an operation, people
have six months or a year to plan an alternative way of payment, rather than be
surprised by a last-minute pulling of the rug under their feet.

Once this is done, cash will die a
natural death and there will be no need for a demonetization drive. This also
automatically removes the threat of counterfeit money – since the economy is cashless,
there is no worry about counterfeit bills. Also, since everything is
electronic, nothing can be hidden. Everything is tracked, and there is no black
money. People will not offer cash bribes because nobody will accept something
that cannot buy anything.

This is exactly what one
of the most advanced countries in the world, Sweden, is actually doing – by
ensuring that everyone has internet connectivity and the necessary devices,
they are eliminating cash. But this is not something that you can do overnight.
It takes years, and is gradual. All the objectives of the government are
achieved – eliminating of black money (not just a stash, but even the generation
of black money); eliminating of counterfeit money; bringing everyone under the
tax net; and moving India to a cashless economy. All this without a single
person dying.

For other articles by Dr.
Seshadri Kumar, please visit http://www.leftbrainwave.com

Disclaimer: All the opinions
expressed in this article are the opinions of Dr. Seshadri Kumar alone and
should not be construed to mean the opinions of any other person or
organization, unless explicitly stated otherwise in the article.

5 comments:

1) You can introduce cheaper smartphones. You cannot force people to buy it. So at the end of this suggested gradual exercise, if a sizeable poor population cries out that they don't have phone and hence this whole exercise is anti-poor, we will be running in circles. A good example of this is the BPL card. The poor (hmmm) want to hold to this card and there do not want a bank account or deposit more than 27k per year.

2) This country works differently than Sweden. So irrelavant comparison. Also in size it is many times over. Additionally the demographics creates other hurdles.

3) The thing is, in this country, unless there is a dire need, nobody wants to bend or learn. This is legacy issue.

4) You have rightly pointed out that " they are average figures for India and do not reflect the urban/rural divide.". But Indis is not rural/urban. It is Urban,Semi-urban,rural and semi-rural. Each acts and reacts differently to economic and social situation. Plus what is good for North India, may not be good for South India, likewise for East and West.

5) I have made plan reports and stuff like that. Believe me the RBI reports you really cannot be sure of 100%.

6) I have also worked with private survey units. They are worse than the government ones. So quoting figures from these report does not really give you a correct picture.

7) Have you tried finding out that out of the 86% currency notes demonitised, what is the % held by peopel who will feel the heat. We don't have those figures.

Nobody can cry foul. They would have been given plenty of notice, unlike in Mr.Modi's scheme where a drastic change was implemented with NO NOTICE. Even with no notice, I don't see riots in the street, so with 6 months or 1 year notice, I dont expect them. Mr. Modi could have easily used his charisma to convince voters that this was necessary (without even needing crocodile tears and hype such as fear of being assassinated.)

The choice is very clear to people. If you have more than 27000 and the law says BPL is for those below that amount, then you are doing domething illegal by claiming benefits. Wouldnt you agree?

If some people cannot buy the phone, the govt can buy it for them. There was a report that the govt is planning to refill each Jan Dhan account with Rs. 15000. Last I checked, you can get a decent smatphone today for Rs. 10k. If the govt develops a lowcost alternative, it may cost Rs. 2000. A govt that can afford to give Rs. 15000 to each JanDhan account can easily provide each poor person with a smartphone.

You say people will only adopt something if there is a dire need. I think not being able to get a train ticket with cash is a dire enough need that people will change.

Point 2:

The point I was making about Sweden is that they are contemplating a cashless world ONLY AFTER first creating the infrastructure. That IS the only way to do it. It is a completely relevant example.

Point 4:

What is your point? Do you have any data to suggest my figures are wrong? Or, more importantly, that my conclusions are wrong?

Points 5 and 6:

These are pointless statements. The RBI data is the best information we have. If you think they are unreliable, please provide a better source of data that is equally comprehensive. But I go by data, not opinions.

Point 7:

No, I don't have that breakup. If you do, let me know. We can only analyze based on what data we have. One can always say that some data is inadequate, but then point out a better alternative.